• Nothing more dangerous than the right-wrong trade
  • Playing with expectations is the hardest psychological challenge
  • Markets exploit this weakness all the time
  • Dealing with right-wrong trade is not easy
  • Important to always trade small
  • Important to walk away from the screen rather try to “make it back”
  • The Puritan ethic of hard work is the absolute wrong thing to do

There is nothing more dangerous in the market than the right-wrong trade. This is basically a trade where you do everything right – pick the right setup, choose the right instrument, and trade in sync with the overall market regime but still manage to lose money as the trade either just stops you out by a tick or misses your target by same and retraces all way to a loss.

Right-Wrong Trade plays with expectations

On paper the right-wrong trade is just another losing trade, but in reality it is far more toxic because it plays with your expectations. As every sadist knows there is nothing more powerful than playing with people’s expectations. Indeed most often our level of pain and pleasure in life has far less to do with the actual event itself but our expectations preceding the event.

As human beings we all carry a million expectations in our head every day. From the mundane  – the  car will start at the press of  button – to the more existential – our health, life and social standing will all be  the same tomorrow as it does today.

The market however carries far more surprises than regular life.. The technical term is Leptokurtic distribution which in layman’s language simply means that things that shouldn’t happen in  a million years occur in financial markets every decade  or so. Furthermore, this state of volatility exists even on the most microscopic level as new information or sudden change in order flow patterns setups even on the shortest time frames.

The right-wrong trade  is the market equivalent of a bad bounce in baseball. In American baseball a ground ball can sometimes hit a pebble on the field and careen in a completely unexpected way away from the fielder. In baseball this is a freak occurrence. In markets this is an everyday event. 

Revenge Trading is often the result

This is what makes the right-wrong trade so treacherous. It very often triggers the impulse to revenge trade. To get it all back because it is … unfair. As numerous psychological studies have shown we as social animals have an innate sense of fairness. We hate being exploited  – and what is a more egregious exploitation than the exploitation of your expectations?

Although I don’t have any scientific evidence for it, I would hazard a guess that the right-wrong trade is one of the leading causes of traders going on tilt. It’s just a thin line between following your trading plan to descent into a frenzied orgy of too much size and endless chase trades. By the time its over the account is in tatters and the trader stands dazed unsure of how it all unwound so quickly.

But of course the reason is clear. The market separated you from your money with the precision of a three-card Monty artist. 

How to Combat the Right-Wrong Trade

What can traders do to avoid this fate? I don’t think it’s possible to sidestep it fully. Almost every great trader blew up at least once and some multiple times because to truly learn the lessons of the right-wrong trade you need to experience it over and over and over again. Still there are some pragmatic things that traders can do to mitigate the damage. 

Keep the smallest possible amount of capital in your trading account. It’s a lot less financially painful to burn through a thousand dollars than ten thousand dollar. It’s never pleasant but the small account serves as your hard stop loss and provides the necessary physical pause for you to gather your composure. This also brings up a second point that can be very helpful – walk away from the screen. This is perhaps the hardest thing to do and flies in the face of our hard wired Puritan upbringing to “power through” adversity but that in fact is the worst thing you can do. If you stay at the screen there is almost no chance that you will recoup your losses quickly and every possibility that you will descend into frenzied revenge trading. 

As Marty Schwartz, one of the greatest S&P futures traders used to say, “You can’t shift into forward from reverse without going into neutral first”. So the best thing to do after a right-wrong trade is absolutely nothing.